Set expectations at the beginning

In New Zealand more than 60% of family owned businesses are transitioned to a second generation. However, this process can be fraught with difficulty and often lead to conflict between siblings and generations. Often this is due to the ‘expectations gap’ – that is differences in expectations between the various parties involved in the succession.

Often the expectations of each party when entering into an arrangement are not documented and so misunderstandings occur between the different parties. I recently worked with a client where this mismatch in expectations led to a severe breakdown in family relationships. Something that could easily have been avoided had these expectations been made clear from the outset of their business relationship.

Create a succession plan to document expectations as soon as possible

In this particular instance, the son had joined the family business ten years ago with a verbal understanding that he would succeed his father and take over the business in due course. This is a typical expectation for a family member entering a business even if they may not be the best person to succeed the parent.

The business had several tough years and then a period of growth. During this time the son was employed as a CEO and after about five or six years began asking his father who acted as Managing Director what was happening with succession. Several discussions were held over the years, however, no firm agreement on the way forward was reached. Following increasing pressure from the son, two years ago the father finally engaged advisers to help structure a succession transaction with his son.

Communicate to keep all beneficiaries happy

It was important to both parents that their three children were treated equally. And so this precluded the gifting of shares in the company to the son. Instead, the father proposed the son buy 49.9% of the equity in the company based on an independent market appraisal, over a period of 5 years, and use dividends and a supporting loan from the family trust to enable this. His view was the family estate would be boosted by the amount received for the shares from the son. The son would then get a one-third entitlement to this value in his inheritance.

The proposal came as a great shock to the son. It was his expectation that he would be succeeding his father as owner of the business. He had not considered that his father would expect him to buy the company, especially not at a commercial valuation.  He believed that he had created the value during his ten years as a CEO and that by buying a company at commercial rates he would be rewarding his two siblings for his effort in creating value.

Plan for the unexpected

It was a classic case of mismatched expectations. And it was around this time that the father was diagnosed with a terminal illness with only two to three years to live. Suddenly, the succession process took on a new urgency.

Complicating the issue was the appointment of a sibling as a trustee to the family trust that held the shares in the family business. As an aside, this is a problematic issue for many New Zealand family trusts. While there is a desire for family members to support their parents in the event they become incapacitated. If they are beneficiaries as well as a trustee this places them in a difficult conflict of interest position anytime a distribution of trust proceeds is considered.

The sister was of the opinion that the brother was lucky to have a job and should not be given a company without paying for it. This led to a conflict between the brother and sister. In particular, because the original succession proposal provided for the trust to maintain a 50.1% shareholding, in other words, control of the company. As CEO and a part-owner as proposed, this was unacceptable to the brother.

Finding a solution that rewards success

The son rightly identified that if he wanted to game the proposal, as CEO he would manage the business value down in order to secure the remaining 50.1% at a reasonable price.  This would disadvantage his siblings in the process. He also had to consider whether he wanted to buy the company or use what would be a substantial inheritance to retire. He also recognised if he were to exit the business, there would have been a negative impact on business value in the short term.

The outcome

Ultimately, a succession transaction was structured. The son was given an option to buy 50.1% of the shares in the company each year at a set value. The set value was an agreed increase over prior year EBITDA, therefore, incentivising the son to exceed this in-order to achieve greater dividend return on his shareholding. The remaining 49.9% shareholding was to be valued in the event of his death and the son to buy the shareholdings from siblings at an agreed 10% discount to market value. This was to reflect the brokerage cost of selling a business and to incentivise the purchase of the business by the son from the family trust.

One of the crucial elements of the succession proposal was agreed and the proposal documented the dividend payment policy to enable the structuring of loan payments to pay for the shares.

The above example illustrates the need for documented agreements from the outset of any business relationship, and in particular between family members. The more informal nature of these working relationships often leads to mismatched expectations which can cause conflict and compromise the business performance.

In particular, the succession of a valuable asset such as a business needs to be managed carefully and with transparency amongst all family members to ensure harmonious family relations. Often family estates can be worth many millions of dollars. Claims on this can be wide and varied, ranging from partners family members to charitable causes. Documenting the succession plan and disseminating provides clarity and transparency to all involved parties and helps maintain the integrity of the family unit. 

Read more about Succession planning at GECA. If you need help with a family member succession process, feel free to get in touch with Giles on 0800 758 766.

The post Family Business Succession Planning appeared first on GECA Chartered Accountants.

It’s never easy to leave a business you’ve been running for years. Whether you’re retiring or moving on to new pastures, closing or selling a business can be technically complicated and emotionally fraught. If your exit or shutdown is unplanned, these issues become even more complex. So, if you’re anywhere near retirement age, it’s a good idea to start thinking about your business exit strategy – what will happen if you have to leave unexpectedly.

Accountants talk about ‘the four Ds’ of unplanned business exits – death, disability, divorce, and departure. These are not necessarily enjoyable to think about, but they are important. Without a solid exit strategy, they can all lead to an unwanted closure of a thriving business or loss of value when a business does close.

A business advisor specialising in succession planning such as an accountant can help you plan for expected and unexpected exits, giving you peace of mind as you head towards retirement.

Dealing with the 4 Ds

Your death, or the death of a business partner, is obviously difficult to plan for. But like a personal will, it’s essential. If you have a family member or co-owner who will take over, an exit strategy will make the transition easier. If the business will be sold or closed after your death, this needs to be planned as well.

Disability covers sickness or injury – and although the unexpected can happen at any stage, it’s particularly important to plan for as you get older. If you’re suddenly unable to run your business, do you have someone to take over? Do you know how much your business is worth so you can sell it quickly if you need to? Without an exit strategy, you could lose the value of your business when you need it most.

If you or your business partner decides to depart the business for personal reasons, you may be able to follow your standard retirement strategy without too many issues. Divorce is a bit more complicated. In the worst-case scenario, you may be forced to sell your business in order to pay your spouse. Alternatively, you could lose expertise and essential business knowledge if you and your spouse were co-owner/operators. Either way, planning ahead can help make a painful personal situation a bit less complicated.

Here’s where many business owners go wrong:

Variations in value

Most business owners think they know roughly what their business is worth – but these estimates are often inaccurate. Many owners judge the value of their business at around what they need for a comfortable retirement, rather than what’s realistic for the current market. When the business ends up being worth much less, they end up disappointed and underfunded when they do retire.

On the other hand, some owners underestimate what their business may be worth, then fail to get the best price when they decide to sell. This also leaves owners with less ready cash for retirement.

Using a business advisor specialising in succession helps you find out exactly what your business is worth before you leave. This information makes it easier to plan your exit strategy – you’ll have a good idea of how much you’ll be left with when you leave, and you can look at other ways to extract value if you’re disappointed with the estimate. If you are forced to leave unexpectedly, you’ll be ready to sell or close without losing potential value.

Other ways to extract value

When it comes to letting go of your business, shutting your doors may be your best option if you can’t sell or hand the reins to a family member. Even if closing is the best option, there may be ways to extract value from the business before you go.

For example, if you’ve been around for a few years, your customer base could be valuable to a similar business. If you simply close without trying to extract that value, you could lose out.

Again, this is where a good advisor comes in. They will be able to find ways to get as much value as possible out of your assets – including your customer base, properties, and physical equipment. Whether you’re retiring on your own terms or leaving for an unexpected reason, extra cash is always welcome.

Leaving it too late

Failing to plan for your exit is one of the most common mistakes business owners make. If you wait until you want to retire, or you’re forced to leave because of illness, divorce, or the death of a business partner, you could end selling or closing too quickly and losing potential value.

Don’t wait until you want out – plan ahead and you’re more likely to get what your business is worth. A specialist advisor or accountant can help you formulate a plan and estimate value ahead of time, so you’re not left empty handed, no matter what happens.

If you need help with growth and succession, then we can help. Get in touch now to find out more about how a GECA Adviser can help plan your successful business exit strategy.

Learn how GECA helps owners of family businesses grow their profits and increase their wealth.

The post Planning for the unexpected: Why you should create an exit strategy before you need it appeared first on GECA Chartered Accountants.